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Business Owners’ Payroll Tax Failure Not Willful, Court Says

Jul 6th 2017
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Taxpayers are strongly advised to avoid the “trust fund penalty” at all costs. Essentially, if you’re a responsible party and willfully fail to deposit payroll taxes on time, you could be held personally liable for 100 percent of the shortfall.

However, in a new case, Byrne v. United States, the owners of an automotive supply company were absolved from this harsh result because they acted reasonably under the circumstances.

Note that a responsible party doesn’t necessarily have to be the person in charge of depositing payroll taxes with the government. It can be anyone who has the duty to perform and the power to direct the collecting, accounting, and payment of trust fund taxes. Frequently, liability extends to owners of a company who aren’t necessarily involved in all the daily operations. 

Similarly, the IRS has a broad interpretation of what constitutes a “willful failure” for this purpose. The omission doesn’t have to be intentional. For instance, the trust fund penalty may be assessed against someone who knows, or should have known, about unpaid payroll taxes.

In the new case, Eagle Trim Inc. President Roger Byrne and CEO Eric Kus both had the ability to hire and fire employees, as well as maintain signature authority on the company’s bank accounts. A controller handled the filing and payment of employee trust fund taxes, while an outside CPA firm conducted year-end audits and prepared the income tax returns.

Based on recommendations from the CPA firm, Eagle Trim hired an accountant and CFO to assist with the daily duties.

Due to financial irregularities, including an overstatement of receivables by the controller, the company failed to pay its payroll taxes on time. Eventually, it had to declare bankruptcy.

Prior to that time, the CPA firm had informed Byrne and Kus about certain problems, but effectively issued a “clean audit” regarding the company’s financial statements. That was revoked when the CPA firm learned of the controller’s fraud.

The IRS assessed the trust fund penalty against the two owners. After a district court ruled that they were liable for a willful failure to pay the taxes, Byrne and Kus appealed to the 6th Circuit Court.

In a May decision, the 6th Circuit Court overturned the penalty. It said that the owners took reasonable steps to ensure the timely payment of taxes and they reasonably believed that the taxes were being paid. Therefore, they did not willfully or recklessly fail to pay the payroll taxes.

Critical point: The owners did not have actual knowledge that the trust fund taxes were not being paid. The record indicated that they didn’t find out about the delinquency until the assessment.

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